CF Related to Stock Options

15,000 options with a strike price of $10.50 per share are exercised and the price to repurchase the shares was $13.00 per share. With regards to the repurchase of shares in the market related to the exercise of employee stock options, which of the following most accurately reflects the economics of the transaction? A) $0 for Operating Activities & $195,000 inflow for Financing Activities B) $37,500 outflow for Operating Activities & $0 for Financing Activities C) $0 for Operating Activities & $37,500 outflow for Financing Activities D) $157,500 outflow for Operating Activities & $195,000 inflow for Financing Activities

C ?


THats what i picked, C but the ***Answer is B*** “In accordance with GAAP, Best Made will report a $37,500 net outflow of cash from financing activities (15,000 options x ($13.00 repurchase price - $10.50 exercise price)). The options are part of the managers’ total compensation, so the cash outflow should be classified as an operating activity” Does this answer make any sense? First it says GAAP dictates it should be a net outflow of cash from Financing for $37.5k but then says the cash outflow should an operating activity. I’m confused :frowning:

Oh i get it now i guess its purely for analytical purposes, in order to truly reflect the substance of the transaction that we reclassify it as an operating activity. There are two sorts of tax benefits created. One due to the compensation expense which is already recognized as an operating activity, while the other which is the one in question here is recognized as a financial cash flow. But there is a ‘mismatch’ of classifications here. In order to better understand it, we make this correction… Well this is what schweser says…

they are asking for the economics of the transaction that is the situation that reflects the true economic reality

Okay i remember that now…makes sense but they explination threw me off… Thanks quantforCFA!

So initially when the shares are issued there is a DTL that is put on the balance sheet with the exercise price*#of shares = CFO. Once these shares are redeemed at a higher price than the exercise price, the amount (market price - excercise price)*number of shares would be adjusted as a CFO and not a CFF?!? Btw, what happens on the B/S with the DTL when the shares a exercised?

Ok First, for the compensation expense, a DTA is created right away When the options are exercised, For the excess tax benefit = no of options ( S - X ) - compensation expense This excess tax benefit is added to the Stock holders equity Note: this excess tax benefit is the CFF compensation expense is the CFO

Thank you quantforCFA, that clears it up for me.